Not long ago, the Federal Reserve (Fed) announced that it plans to keep short-term interest rates near zero until late 2014. The Fed initially pushed rates to that level in 2008, in an effort to stimulate economic growth. Clearly, low interest rates have a wide-ranging impact — but what effect will they have on you, as an individual investor?
If you need income from your investments, then the continuation of ultra-low interest rates may be a matter of some concern, particularly if you own certain types of fixed-income investments, such as certificates of deposit. While CDs are insured, offer return of principal at maturity and provide regular interest payments, they are not risk-free. With low interest rates, you risk losing purchasing power. Still, fixed-rate vehicles may well have a place in your portfolio. If you’re even somewhat dependent on your investments for income, you may need to broaden your search. Here are a few ideas to consider:
Build a bond ladder. Long-term bonds, by their nature, are more subject to interest rate risk than shorterterm vehicles. In other words, interest rates are more likely to rise during the life span of a longer-term bond — and when rates go up, the prices of existing bonds will fall.
To help lower this risk, you may want to build a “ladder” of bonds of varying maturities. Then, if market interest rates are low, you’ll still have your long-term bonds earning higher rates, but if rates rise, you can take advantage of them by reinvesting the proceeds of your maturing short-term bonds. But remember to work with your financial advisor to evaluate whether a bond ladder and the securities held within it are consistent with your investment objectives, risk tolerance and financial circumstances.
Consider dividend-paying stocks. You can find companies that have paid dividends for many consecutive years — and in some cases, increased their dividend payout each year. In 2012, companies listed in the S&P 500 are on track to pay out more than $252 billion in dividends, a record amount, according to data compiled from Standard & Poor’s. (Keep in mind that the S&P 500 is an unmanaged index and is not available for direct investment.) Of course, stock prices will fluctuate in value, and you may receive more or less than your original investment when you sell. Historically, dividend-paying stocks have been less volatile than non-dividend paying stocks.
Be aware, though, that companies can lower or discontinue dividend payments at any time without notice. Past performance is not a guarantee of future results.
Refinance your mortgage. Today’s low rates are good news for borrowers. With tougher standards in place, it may not be as easy to refinance a mortgage as it once was, but if you qualify, you may want to think about refinancing. You may be able to save quite a bit of money on your monthly payments — and lower payments can translate into a greater cash flow. Plus, if you don’t need all the savings, you can put some of the money into an Individual Retirement Account (IRA) or other retirement savings vehicles.
Ultimately, an extended period of low interest rates is just one more factor to consider in creating and adjusting your investment strategy. Work with your financial advisor to help ensure low rates won’t affect your income needs.